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Biotech is a hot topic given that these stocks are delivering their fifth consecutive year of market-leading gains. But industrial biotech isn’t exactly a sexy area of the market.
It is way more interesting to talk about a world filled with high-performance electric cars from Tesla Motors (NASDAQ: TSLA) and new tech gadgets from Apple (NYSE: AAPL) than it is to ponder a giant fermenter cranking out bio-based powders.
But industrial biotech suddenly becomes a lot more topical when you think about what’s in the products you use every day, and how many have ingredients that are potentially harmful.
Let’s pick a timely product – sunscreen.
We all have our favorite sunscreens. But do they actually work? And are the ingredients safe? According to a recent study (I think they put one out every year at this time) by the Environmental Working Group, around 80% of sunscreens offer inferior sun protection or contain worrisome ingredients.
That’s just sunscreen. How about other skincare products? Or household cleaning products? Paint? The clothes on our backs? One has to wonder what exactly is in all of these things.
If you’re anything like me, you wonder … but you also don’t have the time to research every single product. So in our house we tend to err on the organic side when buying products that we frequently touch. Our dish and hand soaps, laundry detergent, skin care products and so on are typically organic or made with bio-based ingredients.
I think many families are the same way. Just like with organic food, it’s not entirely possible (or affordable) to go all in with organic. But when it matters, it makes sense to play it safe.
And this brings me to my main point – that just like with organic food, consumers are demanding cleaner and greener products for everyday goods. And this is driving manufacturers to use cleaner and greener ingredients.
Behind the scenes this means that manufacturers are increasingly turning to bio-based chemicals, also known as sustainable chemicals, for use in everyday products – including clothes, plastics, personal care products, paints and even food.
Many of these bio-based chemicals are “drop in” replacements (i.e., exactly the same) for the petroleum-derived chemicals that currently dominate the market. The fact that they are drop-in replacements is critical to their future use because it means that purchasers – massive companies like Cargill, Bayer (OTC: BAYRY) and DuPont (NYSE: DD) – don’t need to do anything different to integrate them into manufacturing processes. They just replace the petroleum-derived chemicals with the bio-based version and they’re good to go.
The benefits of these sustainable chemicals are many. Obviously they are preferred by many consumers for the reasons just discussed. But beyond that, because they are derived from renewable feedstock they have a lower carbon footprint. And their greenness means that products made from the bio-based chemicals can be advertised as eco-friendly. That’s a bonus for many manufacturers that differentiate based on an eco-friendly supply chain.
The benefits of bio-based chemicals have led to rapid demand growth. Industry-wide growth is expected to be 10% annually. But demand for specific bio-based chemicals is growing far faster.
For example, the global market for succinic acid is expected to grow by 20% to 30% per year over the next five years.
Small quantities of succinic acid are used to make personal care products and food additives (it is approved for these uses by the U.S. Food and Drug Administration), while larger volumes are used to make plastics and resins. Bio-based succinic acid can also be transformed into 1,4-Butanediol (BDO) and Tetrahydrofuran (THF). These chemicals are used to make plastics, polyurethanes, biodegradable polyesters and spandex.
Bio-based succinic acid can replace adipic acid in polyurethanes, which makes for a cleaner manufacturing process (adipic acid production creates nitrous oxide, a greenhouse gas). The global market for adipic acid is currently 3 million tons, of which polyurethanes consume around 25%.
In other words, this single market for polyurethanes that few (if any) of us ever give a single thought holds significant potential for bio-based succinic acid.
Spread that potential across all the possible applications for huge companies with sustainability programs, such as IKEA, Wal-Mart (NYSE: WMT) and Nike (NYSE: NKE) and it’s easy to see how 20% to 30% annual demand growth is just a starting point.
One of the keys to this under-the-radar growth market is that many bio-chemicals are cost-competitive as compared to petroleum-based versions.
The cost advantage depends largely on two variables: the price of oil and the price of the alternative, in most cases corn. I’ve seen examples where at $95-per-barrel oil and $6.50-per-bushel corn (the high in 2013), many clean and green chemicals were 50% cheaper than similar chemicals derived from oil.
That cost advantage has certainly diminished with oil at its current price. But it hasn’t evaporated, especially since corn trades closer to $3.80 a bushel now. With the current price of corn, oil needs to trade down around $30 for many bio-based chemicals to lose their price advantage. And I don’t see oil going that low, at least not for the long term.
Industrial biotech isn’t an area of the market that many analysts are talking about. But there is very large potential with select stocks in the sector. And because chemical plants tend to use little labor but produce a lot of heavy product, manufacturing for bio-based chemicals is likely to grow right here in North America.
For those of you who, like me, enjoy an off-the-beaten-path growth story, it’s worth following small-cap companies in the bio-based chemicals space. The most interesting to me are those that have multi-bagger potential as they race toward large-scale development.
One in particular that I follow is building its first full-scale production plant right now in North America. This plant alone should increase revenue by more than 1,000% over the coming year as the company graduates from development-stage status to full-blown production. And plant No. 2 should be coming within a couple of years too. If you’re interested, you can click here to learn more.
A few other names that I’m aware of, but haven’t researched much, include Codexis (NASDAQ: CDXS), which supplies biocatalysts for various markets, and Solazyme (NASDAQ: SZYM), which sells renewable oils and other bio-products.
I know that Codexis is working under license from GlaxoSmithKline (NYSE: GSK) and is expecting 10% to 19% revenue growth this year. And Solazyme is making inroads in the oilfield services market by partnering with Flotek (NYSE: FTK) to market a drilling lubricant. But I haven’t yet dug deeper into these two companies, so be sure to do your own research if you’re interested in either.
Other, more conservative options are to go with traditional chemical and life science stocks, including Dow Chemical (NYSE: DOW), DuPont and Bayer, though these large-cap companies don’t offer pure-play exposure to bio-based chemicals.
The bottom line is that bio-based chemicals are way off the radar of most investors, but the end products that they go in are front and center. And demand for cleaner and greener products is only going to grow.
To me, this knowledge gap means there is a lot of opportunity for early investors. Yes, the investable options are somewhat limited. But that’s why there is so much potential – to reap the reward you need to decipher the map.
I’ll follow up on this trend in the future. And remember that you can get my research on one pure-play bio-chemical company that is opening its first plant right here in North America by clicking here.
In the meantime, be sure to check out that report on sunscreen. It’s worth a quick read to make sure that what you expect to protect your family this summer will actually do the job.
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